GE Slides on Moody’s Downgrade; Are Investors Overreacting?

General Electric (GE) lost its sterling Aaa rating in 2009, and now it’s fallen another notch. Last night, Moody’s downgraded GE to an Aa3 rating from Aa2 and downgraded GE Capital to A1 from Aa2. Moody’s said the downgrade was necessary because of a change in its methodology. GE shares fell 1.3%, slightly more than the overall market.

“Moody’s believes the risk profiles of market-funded financial institutions, including GECC, are higher than was previously reflected in their ratings,” Moody’s said in a release. “While GECC has improved its liquidity and capital levels since the onset of the credit crisis, Moody’s believes that, notwithstanding these positive steps, there remain material risks associated with the firm’s funding model.”

GECC’s “funding model” means it relies on capital markets, which have (newsflash!) proved unreliable in the past few years.

Without GE Capital, GE would likely be rated Aaa, Moody’s implied in its release. The company’s industrial businesses “continue to have many Aaa-like credit characteristics,” said Moody’s Senior Vice President Russell Solomon, who led the GE review.

“The downgrade reflects Moody’s view of the heightened risk profile inherent to finance companies like GECC, which has strategic importance to GE, rather than any deemed incremental risk related to GE’s industrial business lines” Solomon added.

In short, the finance arm is hanging like an anchor on GE’s balance sheet — without the implied support of its corporate parent, GECC would be rated Baa1, Moody’s said. GECC’s rating could improve if GE itself made it more clear that it will support the finance arm through hell and high water: “To lift GECC’s rating further from its standalone credit profile and equalize it with GE’s rating would require a higher degree of support certainty.”

GE has said it will ask for permission from the Fed to allow GECC to pay a dividend back to the corporate parent. That ruling could have more meaning for the stock.

But some analysts have argued that the downgrade — which had been anticipated for a few weeks — won’t significantly raise GE’s cost of capital.

Morgan Stanley analyst Nigel Coe recently argued:

�[T]he risk of a material increase in GECC cost of funding relative to banking peers is low. While GE Capital does enjoy 50bps lower cost of funding than the US bank group, we show that the cost of GE Capital�s 10Y debt is more consistent with a single-A credit. Therefore, even a 2-notch downgrade to Aa- would be largely irrelevant from a financial perspective and is unlikely to be a major factor in the Fed�s ongoing review.�